An attempt to explain in ordinary language the bizzare bazaar that is our financial system.

Wednesday, December 23, 2009

The Times they are Exchangin'

Today it was announced that the DFM the Dubai local stock market will acquire NASDAQ Dubai (which for convenience and nostalgia I will call by its former name the DIFX) for $121 million. The current owners of the DIFX are NASDAQ OMX (33.3%) and Bourse Dubai (66.7%) bourse Dubai is also the parent of the DFM of which it owns 80%. So in essence Bourse Dubai is consolidating its’ Dubai subsidiaries into a single entity and instead of owning 33% of the DIFX, NASDAQ now owns 1% of the DFM. The valuation of $121 million is only slightly below the $150 million valuation implied when it paid $50 million in cash for its 33% back in 2007. So NASDAQ does take a small write down. Interestingly the transaction is structured such that the portion that goes to NASDAQ is all shares and to Bourse Dubai is all cash.

So what is this all about? Does it bring the DFM and the DIFX closer together? Well today both the DFM and the DIFX are controlled by the same holding company Bourse Dubai which owns 80% of the DFM and 66.6% of the DIFX. Who is the CEO of Bourse Dubai? Essa Kazim. Who is the Chairman of the DFM? Essa Kazim. So both before and after the transaction both the DFM and the DIFX are owned by Dubai entities whose leadership not only share the same goals but in fact are the same person. All that is really happening from the Dubai perspective is that Bourse Dubai is consolidating its’ Dubai assets in a single subsidiary rather in two separate ones though they both continue to have separate trading platforms operational structures and operate in different jurisdictions.

It might be better to think of this as NASDAQ selling rather than as the DFM buying. The DIFX, though it pains me to say it, has not been a success. Rebranding it as NASDAQ Dubai has not helped. Listing derivatives has not helped. These days, being associated with a Dubai Government Related Entity is a liability, not an asset. This transaction enables NASDAQ to go from being a 33% partner in the DIFX to a 1% passive shareholder in the DFM. It has to take a trivial writedown to get it. The terms of the deal enable the DIFX to continue to use the NASDAQ Dubai brand, my guess is that this is not a permanent state of affairs. If NASDAQ Dubai is able to retract its’ brand it will be able to draw to a close an extremely successful set of transactions with Dubai Inc.

At this point it is helpful to remember how we got into this position. In the first half of this decade cross border exchange mergers were all the rage. Several European exchanges joined together to form the Euronext which then merged with the New York Stock Exchange in 2006. Once the NYSE had done the Euronext deal NASDAQ did not want to be left behind and started looking for a European partner. In so doing it made a strategic mistake and took a run at the London Stock Exchange and failed. This left it with a 33% stake in the LSE that it could neither convert into control nor could it sell as it was simply too large to dispose of without crushing the price. At the same time Bourse Dubai was buying up shares in the OMX, a Swedish exchange and more importantly a technology provider to a great many exchanges. Qatar was, as usual, reading day old copies of Gulf News to come up with it’s strategic plan and was also buying up shares in OMX. NASDAQ was also interested and it looked as though a tough bidding war could erupt.

Instead what happened was a complex deal between NASDAQ and Bourse Dubai. Bourse Dubai bought OMX for $4.1 billion in cash and then sold it to NASDAQ for $1.7 billion in cash plus a 28% stake in NASDAQ. Bourse Dubai also agreed to buy the 28% of the LSE from NASDAQ LSE for 14.4GBP per share or about $2.2 billion. NASDAQ also agreed to pay $50 investment for 33% of the DIFX. When the Dubai officials who had negotiated this returned to Dubai there was a sense of triumph among them. Dubai was now a major shareholder in both NASDAQ and the LSE. The NASDAQ had validated the Dubai brand by lending its own name to the DIFX. Emiratis would be represented on the boards of some of the oldest stock exchanges in the world and the QIA were left with their day old copies of Gulf News to plan their next moves. (Which they did by taking a stake in the LSE.)

Well how did it all work out? Well, sure enough NASDAQ is selling out of its $50 million investment in the DIFX for $40 million in shares of the DFM, a $10 million loss. On the other hand it did acquire OMX in its entirety and thereby gained a foothold in Europe and an important exchange technology supplier. It also was able to unload its’ entire LSE stake it used the money to pay down debt and buy back shares which improved its position for the shocks to come in 2008. Gentlemen, high fives all around!!

How did it work out for Bourse Dubai? Well, their 28% stake in NASDAQ which cost them $2.4 billion ($4.1 billion for the OMX shares less $1.7 they got in cash from NASDAQ) is now worth $1.2 billion, a loss of $1.2 billion. Of their LSE stake they have sold 7% leaving them with 21% that would have cost them $1.6 billion is now worth about $700 million, a loss of $900 million. After the deal was announced, LSE shares rallied for some time eventually getting to around 20GBP. Lets assume that when they sold the other 7% they did a good job and earned an additional $100 million meaning their total loss on the LSE stake was $800 million. So on these transactions with NASDAQ Bourse Dubai has lost a total of $2 billion. Ummm... Let's just say it looks like a great trade for the NASDAQ and leave it at that.

So where did Dubai get all the money they needed to finance their entry into the world of international exchange ownership? Where they get all their money: they borrowed it. The next question to ask is how much and when is it due? Hmmmm... According to Morgan Stanley, they borrowed $2.5 billion and its’ due in February of 2010. Whoa! Hold on a second, so back when they borrowed this money their stake in NASDAQ was worth $2.4 billion and their stake in the LSE was worth $1.6 billion or $4 billion. Now, however, those stakes are worth $1.2 billion and $700 million respectively for a combined $1.9 billion. Uh, oh. $1.9 billion is less than the $2.5 billion they borrowed. Sounds like it might be hard to roll that loan forward. Gentlemen, it is time to put on the thinking caps.

What about other assets? Bourse Dubai owns 80% of the DFM, that’s worth $3.2 billion right there, why not pledge that as collateral to extend the loan. Hmmm.... good thought but there are a few problems with that. You can’t enforce a pledge over shares in the UAE and in any case, I’m not sure if you’ve noticed but there have been some articles lately in the press about the dangers of lending money to Dubai Government Related Entities secured by assets inside Dubai....

But wait, what about all that cash on the DFM balance sheet? There’s gotta be $800 million there at least. Yes, but if we pay it out as a dividend we have to share it with the 20% of people who are not the parent company. We’ll probably have to do something like that sooner or later, but it would be better if we could just move the cash straight upward.

Wait a minute, doesn’t the parent company own the DIFX? Why don’t we offer to buy that? It was last valued around $150 million, lets’ call it $120 million so that its’ not egregious. Let’s structure it in such a way that we can pay shares to NASDAQ and cash to the parent. Dubai still controls the whole show, Essa Kazim is still in charge but now we have shipped $80 million in cash upstairs and have avoided having to share any of the transferred cash with the other shareholders. Bingo, we have a winner.

Sound familiar? That’s the deal they struck today.

Most of the above is speculation. I don’t know whether NASDAQ is seeking to minimize its exposure to Dubai though it would be rational. I don’t know whether the financial position of Bourse Dubai would justify this method of sending cash to the parent around the shareholders. I know the losses are real but don’t know whether Bourse Dubai can call on the parent company or DFSF for funds and so this was unnecessary. Though they are speculations I think they are plausible explanations for today’s events. I think that in reality, this is not really about NASDAQ, and it’s not really about the debt issues at Bourse Dubai. It’s about the victory of one political faction over another within in Dubai, and potentially the rebirth of the city, but that is a story for another day.